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Notwithstanding the impact of Covid-19 pandemic, Indian equities delivered surprisingly good returns in CY20 (Nifty/BSE500 gained 15-17% YoY vs. average return of 10-12% for benchmark indices in the preceding decade) and outperformed its Emerging Market (EM) peers excluding China. Further, the Covid-19 induced transitionary economic recession implies that for equities, CY21 has begun in the proverbial ‘Goldilocks’ zone with great expectations – companies would deliver on robust earnings growth forecasts and RBI would exit its loose monetary policy stance in a calibrated manner i.e. record-high valuation multiples will sustain and there is no sudden spike in bond yields.
While there were cues that the FY2022 Union Budget would present an expansionary stance and put fiscal consolidation on the backburner (risking a cut in sovereign rating to below investment grade), what surprised the equities market more was that funding for this spend by the government did not come with a rider of higher effective tax rates (individual or corporate) and no major devil in the detail.
In January, assuming there would no widespread resurgence of Covid-19 pandemic and/or geo-political exigencies, we envisaged four scenarios for India’s benchmark equity returns in CY21 based primarily on the interplay between current/historical earnings multiples and underlying earnings forecasts for FY21-23. The returns ranged between -5% to 20%, with the base case being a 16-18% upside (FY22/FY23/FY24 earnings growth forecast of approximately 30%/25%/20% and one-year forward multiples sustaining at CY20-end level of 20-21x), albeit after a meaningful intra-year correction. The inflexion point could well be determined by the trajectory of FY23 earnings revisions sometime by mid-CY21.
So where should one look to invest? In the context of global/domestic economic recovery, ample liquidity, rich valuations and FOMO in the ongoing rally, sector rotation is likely to take centerstage this year. Specifically, examining the valuation of key sectors, while 1-yr forward P/E of healthcare, IT, consumer durables/discretionary, auto and realty are ~2SD above their respective 5-yr averages, the BFSI space is relatively inexpensive (1-yr forward price/book hovering closer to 1SD above its 5-yr average).
Putting all this together, our top sector preferences for CY21 are infra/construction plays, cyclicals (metals/capital goods etc.) and the BFSI space. We would be neutral on the consumer space (prefer discretionary over staples), telecom, chemicals, and auto space. As and when the intra-year correction sets in (potentially within 1HCY21), we would advocate rotation into defensive-growth options – sectors such as IT, pharma, insurance and utilities.
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